Will public deficit reduction encourage private sector growth, or undermine a needed stimulus to recovery & lead to Japan-style stagnation?
What case is there for reducing the budget deficit and public debt burden now? Will such actions save the economy from sharply reduced growth or will cutting government spending and/or raising taxes lead to a collapse of demand and a long period of Japanese style deflation and stagnation?
Economists sharply disagree on what many are now calling “the austerity debate.” Some prominent economists (for example, INET Advisor Kenneth Rogoff) believe that cutting deficits and reducing debt is essential to inspire confidence in financial markets and to ensure that long-term economic growth is not damaged (see Rogoff's recent op-ed here. Others (for example Paul Krugman and Robert Skidelsky, who spoke at INET’s inaugural conference) think that any attempt to reduce expenditures today will be self-defeating since it will further weaken the economy, lead to lower growth and reduced tax revenues in the future, and so greater deficits and debt in the end.
This deficit debate is extremely relevant right now. The cut-the-deficit view has become quite pronounced in Europe, with the new Conservative government’s austerity drive in the United Kingdom as a prime example. On the other side, the Obama Administration has actively urged developed nations to maintain their public investment until the global economy more fully recovers.
This deficit debate is not new. In fact, John Maynard Keynes and Fredrik Hayek, the two economic giants of the 1930s who we partly based our inaugural conference at King’s College on, laid our their version of the debate in dueling newspaper articles in October 1932 (See the images here.)
What new ideas does economics have to offer about these issues today? Richard Koo's wide-ranging analysis of the Japanese deflation is one of them, based on the nearest historical example of a developed country experiencing a real-estate and financial crash followed by an economic downturn. In a talk that kicked off INET’s inaugural conference in Cambridge and in a deep interview that followed it, Koo lays out his concept of a “balance sheet recession,” the idea that in severe downturns such as this one, the normal functioning of financial markets is disrupted. In this analysis, the private sector does not take advantage of easy liquidity and borrow at low interest rates to invest, but instead seeks to pay down debt and shore up their balance sheets. This leads to a situation where the private economy begins to contract as all companies or households try to cut back on borrowing and investing, which increases the incentive for the private sector to save. In such a spiral, Koo argues, the only way to prevent the economy from a complete collapse is to have the government borrow from financial markets and spend while actors in the private sector consolidate their balance sheets and recover.
There are other ways to view the issue. Ken Rogoff lays out his perspective in a countervailing talk given alongside Koo at the opening of our inaugural conference. Within that camp, questions are raised about what kinds of expenditures can be reasonably reduced without undermining growth too much. There is debate within the anti-austerity group as well about the composition of spending. How much of expenditure should be focused on the short-term and how much on more long-term projects? INET Advisor Jeff Sachs argues for the long-term investments.
Clearly this overarching question about what to do about public deficits is a rich one, one which we want our community to ponder, and hopefully, come up with some fresh new insights as well.
Related Questions
Question on the Stimulus Route: What are the kinds of expenditures that should be undertaken if further stimulus proceeds? Does long-term expenditure constitute a better way of thinking about stimulus, such as what Jeff Sachs advocates (FT of 7/22), or Robert Leighninger in “ Long-Range Public Investment: The Forgotten Legacy of the New Deal (Social Problems and Social Issues (Univ of South Carolina)?”
Question on the Reduction Route: If deficit reduction is to take place, what kinds of expenditures should be cut? Is reducing expenditures on social security, as suggested by some, a viable/credible/desirable way of reducing deficits but protecting growth? Are there other cuts to expenditures that should be considered?
More Fundamental Question: A fundamental assumption that underlies all of these questions is that we need an economy that grows. Is it possible to transition to an economy that does a better job of supporting people and the planet without growth? And if so, how do we think about deficits within that context?" (Peter Victor's book, "Managing without Growth: Slower by Design and Not Disaster" is one example of this kind of thinking.)
Historical Question: What can historical examples beyond Koo’s Japanese example provide in terms of guidance to the current challenges? Do the examples of countries (including Sweden, United Kingdom, and 18 others) outlined in Alesina and Ardagna (2010) PDF have much to say about the current situation, or is the situation more akin to that described by Almunia et al. 2010. How useful is it to the United States, the largest economic power in the world that also maintains the world’s defacto currency, that other countries (such as Canada) were able to export their way out of a recession, or that Ireland could devalue its currency to stimulate foreign investment?
Featured Profiles
 |  |  |  |  |
|---|---|---|---|---|
| KENNETH ROGOFF PROFESSOR OF ECONOMICS HARVARD UNIVERSITY | JEFFREY SACHS DIRECTOR THE EARTH INSTITUTE | RICHARD KOO CHIEF ECONOMIST NOMURA RESEARCH INSTITUTE | JOHN CASSIDY AUTHOR | MARK BLYTH PROFESSOR OF INTERNATIONAL POLITICAL ECONOMY BROWN UNIVERSITY |
| Suggest Books | Online Resources |
|---|---|
|
The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession: Richard Koo
This Time Is Different: Eight Centuries of Financial Folly: Kenneth Rogoff and Carmen Reinhart
Long-Range Public Investment: The Forgotten Legacy of the New Deal: Robert D. Leighninger Jr.
| The Austeri Sow the Seeds of Long-Term Growth by Jeffrey Sachs Why the Battle is Joined Over Tightening by Martin Wolf These Anti-Keynesian Arguments Look Flimsy by Lord Skidelsky Trichet's Whole Doesn't Equal the Sum of its Parts by Mark Blyth
James Galbraith’s Testimony Blasts Fiscal Commission (New Deal 2.0)
Notes on Ken Rogoff by Paul Krugman, New York Times (Wonkish)
|
ty Debate
Overreaching Claims of Debt "Threshold" Suffer from Theoretical and Empirical Flaws
Comments
Sorry but this is merely closing your eyes instead of reviewing the history of the government debt and its relationship to prosperity and depression
Nothing in economics is "that simple" that it can be reduced to a one-liner. And there are few "no-brainers", least of all when their supposed basis is plucked from thin air. I'm afraid "commitments in line with productive capacity" doesn't even mean anything. In line how? With capacity determined on what basis? Just about any commitment can be "in line with productive capacity": just look at the war effort that drove public debt up to 2.38 times GDP in the 1940s. It's about national priorities and management, not merely exclaiming that some random figure breaches an entirely arbitrary imagined limit. As for credibility, we have plenty of that without premature cuts: we may not be so fortunate if harebrained austerity measures end up stifling recovery and widening the deficit rather than narrowing it.
Dear all,
WIth transparency, I believe that is possible.
Currently we are in XXI century with political structure of XIX. When the political campaigns are full of uncertains, without any budget clarification, the economy suffers immediatly.
Huge ammount of debts are nothing more than uncontrolled decisions by each government.
Currently we are in XXI century. Software for example, is an powerfull tool to be used in order to check all debts from the State. These debts should be transparent and clear for any citizen. Then each person will be allowed to understand the debts clearly and use it in their own choices.
Best Regards
Francisco Miguel Sousa
Lisbon, Portugal
Author of Tuganomics
A good piece, but I'd have paid more attention to the downward spiral of spending, consumption, output, income, employment & revenue. Social justice arguments just aren't enough in these blighted times: just look at the demonisation of of the very people hit hardest by a crisis that they alone didn't have a hand in. From anger at the bankers we've now shifted to hatred of the poor, the unemployed, anyone who can be picked on with impunity. I'd have also used the analogy with a local business: suppose it's your neighbours and customers losing their jobs, being driven further into poverty, maybe losing their homes - where's your growth going to come from? And finally there's a case for who's more likely to spend the money now that's needed to keep the economy afloat - the affluent who don't face constraints, or the poor who've barely enough as it is? I'm afraid the only way to win the justice argument is by appealing to the self-interest of the haves, though the lure of contempt for those beneath them seems to eclipse even that.
In the UK we seem to have ended up with just about the most mindless austerity package imaginable despite most voters having rejected premature cuts at the May election: we've now no realistic hope of getting unemployment down in the next five years owing to a million likely job losses and half a million additional people of working age, yet it's the jobless who are to bear the worst of the cuts. I fear this is all going to end very badly indeed.
In his recent article America’s Political Class Struggle (http://www.project-syndicate.org/commentary/sachs173/English) Jeffrey D. Sachs asserts:
”The Republican Party’s real game is to try to lock that income and wealth advantage into place.” has prompted me to suggest that the lock of their income and wealth advantage into place is likely to be via Congress’s voting on the recommendations of the Fiscal Commission. Since the Fiscal Commission choose the less transparent route of only posting live testimony to its Website, I have included below my comments to Fiscal Commission prior to its first meeting in April 2010:
Comments Regarding the Scope of National Commission on Fiscal Responsibility and Reform
Introduction
In June 1980 the broadcast of the NBC White Paper If Japan Can…Why Can’t We?; sent major U.S. corporations looking for W. Edwards Deming in his Washington, DC, basement office. The reason: many U.S. industries, measured by key matrix, peaked in the mid-late 1960’s and were increasingly challenged competitively by the Japanese. The NBC documentary asserted that America’s declining competitiveness and rate of productivity would make the United States’ “guns and butter” policies of the past unsustainable and our children will be the first generation of American to have a lower standard of living than their parents. For more information about If Japan can…Why Can’t We? - click the link that follows:
http://en.wikipedia.org/wiki/If_Japan_Can..._Why_Can't_We%3F
Deming’s spent the last 13 years of his life trying to prevent the United State from committing suicide. His blueprint for transformation was instrumental to the Japanese economic miracle after World War II and this same blueprint helped transform many American companies, including Ford, after 1980. Ford’s ability to thrive, without bailout assistance, is testimony to his sustainable framework. Deming networks exist in most countries; in fact, from 2001 through 2008 companies from India were awarded more Deming Prizes for quality (15) than all other countries combined.
In addition to U.S. industries’ competitiveness peaking in the mid-late 1960s, the following were at levels that have not been seen since:
The percentage of the federal budget funded by corporate taxes
The level of employee post-retirement benefits funded by employers
As wide a dispersion of annual income across the population
Paradoxically, in spite of America’s declining competitiveness and rate of productivity, the 40 years through 2006 has resulted in:
The percentage of the annual income accruing to the top 20% of the population (the special interest) reaching an all-time high
The percentage of the federal budget funded by corporate taxes reaching an all time low
The level of employee post-retirement benefits funded by employers reaching an all time low
The aforementioned, have resulted in the bottom 80% (the common interest) bearing the brunt of America’s declining competitiveness and rate of productivity.
The predominate reason corporate taxes were lowered and businesses justified freezing/terminating the funding of employee post-retirement benefits was to make America companies more competitive. Yet in spite of the lack of increased competitiveness, the percentage of the annual income accruing to the top 20% of the population reached an all-time high.
Scope of National Commission on Fiscal Responsibility and Reform
The scope of The Commissions work, perhaps more than anything else, will determine how history judges The Commission. Too many interest groups will want instant pudding and try to influence The Commission to focus more on the effects of the last 40 years, rather than the root causes. Over the 40 year period from 1969 through 2008, one major political party controlled the legislative branch of the Federal Government, 70% of the time; while the other major political party controlled the executive branch of the Federal Government, 70% of the time. As a result there is ample blame to go around. Unfortunately, there is a fine line between holding leaders accountable and being views as partaking in the blame game, but this should not deter The Commission from holding interest groups accountable. Self-interest partisans have over-promised and have set the stage for to gross under-deliver to the American people. The Commission’s work should above all be balanced and sustainable. Some interest groups have pointed to the follow deficits as being responsible for our current fiscal crisis:
The Trade Deficit(s)
The Saving Deficit
The Leadership Deficit(s)
The Budget Deficit(s)
Based on the heretofore introduction, perhaps The Productivity Deficit(s) should be added.
Trade deficit challenges may not be considered as compatible to the mandate of The Commission as other deficits, however, if The Commission determines that roots causes of trade deficits are also among the root causes of America’s current fiscal crisis, trade deficit root causes warrants disclosure.
With globalization, addressing American’s saving deficit has special challenges, since policies designed to increase savings may not benefit our domestic economy/society; increased savings may benefit other countries more than the U.S. because these savings may result in increased investments by Americans abroad. The reduced dividend and capital gains tax rates, which are scheduled to sunset, did not result in increased savings, in facts savings rates reached all time lows. Perhaps savings targeted toward enhancing our domestic economy should be encouraged; this could take the form of individual investment, sovereign wealth fund investment or both.
The leadership deficit(s) are not limited to public officeholders. All individuals in positions of authority have the primary responsibility for the system within which those that they lead and/or have authority over, operate.
Budget deficit(s) have numerous moving parts. Often not discussed are tax discounts, tax credits and tax deferrals, which have been estimated to account for 25% of the U.S. Government’s total spending. The U.S. Federal Income Tax Code should be justified from a domestic economic and societal benefit standpoint.
For example, the current U.S. Federal Income Tax Code provides substantial tax rate discounts on long-term gains from the sale of capital assets held for longer than 1 year; however not all capital assets provide meaningful economic and societal benefits. Some provide substantial benefits in terms of fostering entrepreneurship, creating jobs and economic growth, while others actually detract from domestic economic growth, e.g., commodity speculation (causing bubbles), investing in foreign stocks and exchange traded fund (ETFs) which are in substance speculative vehicles are among those that generally detract.
Corporate obsession with quarterly earnings is to some degree influenced by the ability to achieve long-term capital gains treatment for holdings, as short as one year and one day. From 1934 to 1941, taxpayers could exclude: 20, 40, 60, and 70 percent of gains on assets held 1, 2, 5, and 10 years, respectively. This graded exclusion from taxation encourages genuine long-term investing and discourages hot-money investing which often results in bubbles.
We live in a debt-money system. Money (M1) consists almost entirely of debt (demand deposits) that private banks create in the course of lending. If firms and households are not willing to borrow enough to keep the supply of debt money up, their ordinary repayments of debt reduce the money supply, resulting in deflation. In such conditions, if government does not step in and borrow, a deflationary collapse ensues. Public deficits are needed not because the spending is needed, or even desirable, but because additional debt money must be conjured to stave off deflation.
Thus we have the spectacle of governments borrowing money from private banks -- money those banks create ex nihilo, remember -- in order to give it back to the very same banks they are borrowing it from to save them from the consequences of their previous excessive debt-money conjuring. And to cap it off, government (i.e., the long-suffering taxpayer) will then also repay this borrowed-into-existence debt money to the banks, but with interest!
A growing economy requires a growing money supply. As long as money is debt, there is no way out of ever-increasing debt but zero or negative growth. SOMEONE has to borrow money into existence. If firms and households won't borrow enough, government has to do it.
Of course deficits have to be reduced. The only argument to the contrary is the idea that we can somehow extend and pretend the current situation, while hopefully receiving some economic miracle that increases productivity in a manner not seen in decades.
We forget. We are in a credit based monetary system. As per its etymology "CREDERE" it is based on credibility. Thus, our monetary system is based on an implicit social contract whereby we can exchange money for labor. If the system ceases to be credible then it ceases to exist. It's that simple
You can only credibly pay if your committments are in line with your productive capacity. It is thus a no brainer. Will it be painful? Of course, but the time for easy answers passed at least a decade ago.
Regards,
Nothing in economics is "that simple" that it can be reduced to a one-liner. And there are few "no-brainers", least of all when their supposed basis is plucked from thin air. I'm afraid "commitments in line with productive capacity" doesn't even mean anything. In line how? With capacity determined on what basis? Just about any commitment can be "in line with productive capacity": just look at the war effort that drove public debt up to 2.38 times GDP in the 1940s. It's about national priorities and management, not merely exclaiming that some random figure breaches an entirely arbitrary imagined limit. As for credibility, we have plenty of that without premature cuts: we may not be so fortunate if harebrained austerity measures end up stifling recovery and widening the deficit rather than narrowing it.
Sorry but this is merely closing your eyes instead of reviewing the history of the government debt and its relationship to prosperity and depression
Post new comment